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What Really is Happening with Housing Prices? The CPI Won't Tell You - C.D. Howe Institute

TORONTO, Sept. 12, 2012 /CNW/ - The Bank of Canada needs a better
inflation indicator that is more sensitive to swings in house prices
than the Consumer Price Index (CPI), according to a new report from the
C.D. Howe Institute. In "Housing Bubbles and the Consumer Price Index:
A Proposal for a Better Inflation Indicator," Philippe Bergevin points
out the CPI has not usefully reflected the rapid run-up in housing
prices in recent years. He proposes a new official inflation indicator
for monetary policy purposes that would better reflect the prices of
houses sold in the market.

"The use of assumed prices for dwellings rather than actual prices for
houses and the inclusion of a mortgage interest component make the CPI
less sensitive than otherwise to housing price changes," notes
Bergevin. The main concern, he adds, is that the CPI's insensitivity to
housing could potentially cause the central bank - reassured by its
imperfect indicator that inflation is under control - to keep rates too
low for too long.

Of course, the Bank of Canada has access to a wide array of data that
provide information on the housing market. Yet it is hard for a central
bank to tune or communicate monetary policy if its actions cannot
easily be linked to its inflation-targeting mandate.

Bergevin recommends that Statistics Canada construct and maintain, in
addition to the current CPI, an inflation indicator that treats housing
like other consumption goods and is based on a net-purchases approach
for owner-occupied housing. This approach measures changes in market
prices - transaction prices - for owned accommodation; it treats the
purchase of a house exactly like any other purchase and doesn't
consider how the purchase is financed, meaning it does not include an
element relating to interest rates. "As currently measured, the housing
component of the CPI drops when interest rates fall, which sends the
wrong signal about inflation since lower rates support higher than
otherwise housing prices," notes Bergevin.

The report further recommends that, should this inflation indicator be
established, the Bank of Canada monitor it on a continuing basis and
consider it when setting policy rates. Over time, the Bank of Canada
may even consider adopting the proposed measure as its official
inflation indicator.